Why I don't use watch lists

I remember as a kid sitting in a chair near our kitchen with my grandfather two chairs away.  I was leafing through a toy catalog.  The catalog's pages were worn and I knew the items and their prices by heart.  Suddenly my grandfather looked at me and said "What are you doing?  Looking at all the things you can't buy but wish you could?"  I was stung by the criticism, but he was right.  I had almost no ability to purchase any of the items.  I was just envying items I couldn't have.  As I reflected on this story recently it reminded me of why I don't keep a stock watch list or research stocks that I wish I can buy someday.

This current moment is all we have.  What has already happened doesn't exist outside of our memory and what happens next isn't guaranteed and is unknown.  We need to focus on the now, because in the now we can take action.  We might regret action taken in the past, but it can't be changed.  We can imagine what action we might take in the future, but futures never work out like we imagine.

When I'm looking for an investment I survey every potential investment candidate available at the current time.  I do this because these are the opportunities that I can take action on now.  From that pool of opportunities I'll research until I find one I wish to add to my portfolio.  

It's happened that I've purchased a number of names from a given pool at once.  I've also passed on investing anything at all if the current opportunity set isn't desirable.  By regardless of the eventual action I take I'm only evaluating the current opportunity set.

This strategy differs from other investors.  Most investors keep a watch list of companies they'd like to invest in at a given price.  I know investors who spend most of their research time researching companies that they might never have the opportunity to purchase.  The idea behind this is that they put in the research hours before an opportunity occurs so when it does finally happen they can act quickly.  This is the theory at least.

Part of the reason the investing public believes that investors should endlessly research companies, even ones they will never purchase is because this is what "great investors" tell them.  In interviews professional investors who understand Marketing 101 utter things like: "we never stop researching" or "We're always hunting for new ideas."  This makes perfect sense when you look at things from their vantage point.  A professional is getting paid for results, and their clients want the assurance that their manager is always at work always ready to make money for them.

I know a number of professional investment managers, some with great records.  I don't know if they're always working, but what I do know is they're always able to meet for lunch or take a phone call, and they're never in a hurry to leave.  It's a very flexible job, and for those with talent and savvy it's possible to earn great returns with less than full time work.  Not that clients would ever know this..

There's a misnomer that hard work generates results.  Work is required, but hard work alone doesn't guarantee anything except for being tired.  The problem with this myth is that if you look at top athletes or the top of anything skilled activity the highest performers are set apart mentally, physically, or genetically.  Some endurance athletes don't generate as much lactic acid as everyone else enabling them to continue when the crowd quits.  Top musicians have an ear for songs and so on and so forth.

If someone doesn't have a musical ear no matter how much they work they will never be a world-renowned musician.  The same is true for any skill set.  Hard work can move you past the average Joe or Jane in the middle of the pack, but hard work won't land you in the top.  The top is reserved for those with an exceptional gifting from birth coupled with time, chance, and some work mixed in.

The same is true for the top investors as well.  Warren Buffett has a gifting that allows him to size up opportunity and act in ways that others can't.  No matter how many annual reports one reads, or how many Munger quotes they parrot, or how many Dempster Mills write-ups they read they'll never replicate him.  It'd be like someone thinking they can become Usain Bolt by wearing the right shoes, practicing in Jamacia and doing the famous bolt stance after each race.

Just because someone famous, or someone in the newspaper (or online) does something doesn't mean that everyone should do it.  In some cases the opposite is true.  Investment managers profiled consider their interviews to be marketing material, not instructional information anyone can use.  In fact the opposite might be true.  Some managers might purposefully leave out their secrets as to give themselves an advantage.  

How does all of this tie into investing watch lists?  I don't think investors need to be researching companies because guru investors proclaim they're constantly researching.  Most professionals are talking to clients, managing their employees, managing their back office systems, prospecting for new clients, and in their remaining time looking for new investments.

Another reason, and possibly a more pertinent reason to avoid watch lists is because the current doesn't mimic the future.  Companies and their results reflect the current and past environments, not the future environment.  This seems like common sense, and it is, but common sense isn't that common either.

Let's take the most common use of a watch list.  One researches a stock that's compounded capital at high rates for years or decades but the current price is too high.  In theory all of this research will enable the investor to act and purchase this quality company once the price is lower.  Here's the problem, no one ever knows what will cause the price to crater.  Maybe the economy hits a recession and this business that's compounded capital sits at the cross hairs of public policy as a result of the recession, will their out-performance continue in the future?  Or how about the situation where the company changes and adapts to the new economic situation, will their past results apply to the future now that they've changed?

When the economic or market situation changes such that watch list stocks are suddenly attractive it's often the case that prior research needs to be discarded.  This is because in the new environment the old research isn't applicable.

Another consideration is whether the prior researched name is still the best opportunity in a market dislocation.  Given two stocks worth a hypothetical $100 per share in a market dip is it better to buy the previously researched company at $80 or another company that isn't quite as high quality for $65?  Maybe the $15 differential in this case is easy to brush away and say "I'd pay $15 for quality and give up that return."  But what happens with the differential grows?  What if it's $80 for the quality company and $25 for a similar company with a few warts?  You'll need a lot of compounding to make up that differential.

When the market crashes dislocations happen quickly and to everyone's repeated surprise prices remain somewhat efficient.  Debt laden companies drop like rocks whereas debt free companies with earnings power don't drop as much.  These quality companies that investors have spent hundreds of hours researching don't drop enough to merit a buy.  Whereas there are companies that drop like rocks that are merely babies thrown out with the bathwater.

I always want to be evaluating the current opportunities, not ones I wish will happen.  Maybe watch lists should be renamed wish lists.  These lists are similar to the toy catalogs I'd browse as a kid.  Full of items that I wished I could purchase.  But now as an adult with the means to purchase any of those toys I don't have a desire to buy them anymore.  This is true for watch lists as well.

I talk more about my system for screening and tracking investment ideas in my Investing System course. Get it here.